An Overview of the Cost Burden of Pension/OPEB Plans Alicia H. Munnell and Jean-Pierre Aubry Center for Retirement Research at Boston College 5th Annual Municipal Finance Conference Washington, DC July 12, 2016
People often generalize about the costs of state pensions. “States are staring at a trillion - dollar pension hole.” ̶ CBS MoneyWatch “ Pensions pose time bombs for budgets .” ̶ The Pew Charitable Trusts “Debt woes: Can Illinois (or your state) avoid becoming the next Greece?” ̶ The Christian Science Monitor 1
But this approach is too narrow to capture costs… Jurisdiction Pensions OPEBs Interest costs X States Counties Cities 2
…and too broad to inform policy. State Pension Costs as a Percentage of Own-Source Revenue for States with Highest and Lowest Burdens, 2014 20% 14.9% 15% 10% Average: 4.3% 5% 0.9% 0% NJ, IL, CT FL, IA, NE Sources: Authors’ calculations based on various FY 2014 plan and government financial reports and actuarial valuations; and U.S. Census Bureau (2014). 3
So, we need to look at the costs of all jurisdictions and report individual results. Percentage of State, County, and City Payrolls Covered by Sample, 2012 100% 100% 80% 60% 46% 43% 40% 20% 0% States Counties Cities (50) (178) (173) Source: Authors’ calculations based on U.S. Census Bureau ( 2012). 4
Calculating cost burdens requires three steps. 1. Applying GASB 68. (Who’s on the hook?) 2. Calculating pension & OPEB expenses. (For how much?) 3. Choosing appropriate revenue base. (Relative to what?) 5
First step: Allocate liabilities by responsibility, not administration, per GASB 68. PERS (covers state, county, and city employees) State government City governments County governments 6
Once allocated, a large share of pension liabilities shifts from states to localities. Distribution of Pension Liability Before and After GASB 68, in Billions $5,000 By government administration By government responsibility $3,823 $4,000 $3,000 $2,000 $1,585 $1,136 $1,122 $1,000 $683 $408 $199 $95 $0 States Counties Cities School districts Sources: Authors’ calculations based on various FY 2014 plan and government financial reports and actuarial valuations; and U.S. Censu s Bureau (2014). 7
Second step: Calculate expenses. • What assumed rate of return? • What amortization method? 8
Assumed returns vary, but average is 7.6 percent. Distribution of Assumed Returns for Public Plans, FY 2015 100% 80% 76.7% Average = 7.6% 60% 40% 20% 14.5% 4.5% 3.1% 1.3% 0% <7 7-7.4 7.5-7.9 8-8.4 8.5+ Sources : Various 2015 actuarial valuations; and Public Plans Database (2015). 9
Assumptions are not out of line with historical returns. 10-Year and 30-Year Geometric Nominal Returns for Hypothetical Portfolios of 65 Percent Stocks and 35 Percent Bonds, 1955-2014 16% 12% 8% 4% Assumption: 7.6% 10-year: 9.1% 30-year: 10.1% 0% 1955 1964 1973 1982 1991 2000 2009 Sources: Authors’ calculations from Morningstar, Inc. (2015b); and French (2015). 10
However, many financial experts expect much lower returns going forward. Expected Nominal Returns for U.S. Equities from Selected Financial Firms, 2015-2016 Average annual Horizon Firm nominal returns (%) (years) Bogle and Nolan a 7.0 10 Charles Schwab 6.3 10 4.7 – 5.5 Goldman Sachs 5 GMO -0.1 7 Slow growth: 6.0 – 6.5 McKinsey 20 Growth recovery: 8.0 – 9.0 6.0 – 7.0 Morningstar b Next few decades Research Affiliates c 3.2 10 a The authors are both affiliated with Vanguard’s Bogle Financial Markets Research Center. b Josh Peters, Morningstar Director of Equity-Income Strategy. c Research Affiliates projects a 1.2-percent real equity return; the projection is converted to a nominal value by adding 2-percent inflation. Sources: Bogle and Nolan (2015); GMO (2016); Goldman Sachs (2016); McKinsey Global Institute (2016); Morningstar (2015a); and Research Affiliates (2016). 11
When in doubt, we follow Michael Cembalest of JP Morgan, who uses a 6-percent rate. Photo credit: Barron’s (2009). 12
In terms of amortization method, our choice is 30-year, level dollar, closed. Percentage-Point Increase in State/Local Funded Ratios Starting from 73 Percent, After Paying Full ARC for 30 Years 30% 27% 20% 14% 10% 0% Level dollar ̶ closed Level percent ̶ open Source: Authors’ calculations. 13
Final step: Choose a revenue base, a task complicated by intergovernmental transfers. Sources of Total Net Revenue, by Level of Government, 2014 Intergovernmental transfers Own-source Inflows from: Outflows Net transfers revenue Federal State Local Level of government State 42.2% 0.0% 1.1% 40.2% 3.1% 96.9% County 3.8 30.4 2.5 3.7 32.9 67.1 City 6.8 13.1 3.1 2.7 20.3 79.7 Total 24.6 9.1 2.0 22.2 13.4 86.6 Source: Authors’ calculations from U.S. Census Bureau ( 2014). 14
Now for results: Start with states and pension costs as share of own-source revenues. States: Current and Required Pension Payments as a Percentage of Own-Source Revenue, 2014 70% 60% Required payments 50% Current payments 40% 30% 20% 10% 0% IL NJ CT HI KY MA RI DE MD LA AK SC WV PA CA TX ME IN NH VT CO MO NY MT NM MS MI AL WA GA VA SD OH NV OK KS WI AR OR NC ID TN FL UT WY MN AZ IA ND NE Sources: Authors’ calculations based on various FY 2014 plan and government financial reports and actuarial valuations; and U.S. Census Bureau (2014). 15
Next, we look at OPEB costs. States: Current and Required OPEB Payments as a Percentage of Own-Source Revenue, 2014 70% Required payments 60% Current payments 50% 40% 30% 20% 10% 0% IL NJ CT HI KY MA RI DE MD LA AK SC WV PA CA TX ME IN NH VT CO MO NY MT NM MS MI AL WA GA VA SD OH NV OK KS WI AR OR NC ID TN FL UT WY MN AZ IA ND NE Sources: Authors’ calculations based on various FY 2014 plan and government financial reports and actuarial valuations; and U.S. Census Bureau (2014). 16
And, then, we add interest payments to present a combined total. States: Current and Required Pension, OPEB, and Interest Payments as a Percentage of Own-Source Revenue, 2014 70% Required payments 60% Current payments 50% 40% 30% 20% 10% 0% IL CT MA RI MD SC PA CA ME IN CO MO MT MS MI SD ID FL MN IA NJ HI KY DE LA AK WV TX NH VT NY NM AL WA GA VA OH NV OK KS WI AR OR NC TN UT WY AZ ND NE Sources: Authors’ calculations based on various FY 2014 plan and government financial reports and actuarial valuations; and U.S. Census Bureau (2014). 17
It is also helpful to look at how the required payments break down by source of cost. States: Required Payments for Pensions, OPEB, and Interest Payments as a Percentage of Own-Source Revenue, 2014 70% Debt service 60% Required OPEB payments Required pension payments 50% 40% 30% 20% 10% 0% IL NJ CT HI KY MA RI DE MD LA AK SC WV PA CA TX ME IN NH VT CO MO NY MT NM MS MI AL WA GA VA SD OH NV OK KS WI AR OR NC ID TN FL UT WY MN AZ IA ND NE Sources: Authors’ calculations based on various FY 2014 plan and government financial reports and actuarial valuations; and U.S. Census Bureau (2014). 18
Here are the comparable results for counties… Counties: Required Payments for Pensions, OPEB, and Interest Payments as a Percentage of Own-Source Revenue, 2014 70% Debt service 60% Required OPEB payments Required pension payments 50% 40% 30% 20% 10% 0% Fresno, CA Sacramento, CA Kern, CA Cook, IL Los Angeles, CA Orange, CA San Diego, CA Prince Georges, MD Fairfax, VA San Bernardino, CA Wake, NC Wayne, MI Hamilton, OH Santa Clara, CA Clark, NV Riverside, CA Mecklenburg, NC Essex, NJ Milwaukee, WI Tarrant, TX Alameda, CA Harris, TX Travis, TX Maricopa, AZ Miami-Dade, FL Contra Costa, CA Macomb, MI King, WA Allegheny, PA Du Page, IL Broward, FL Cuyahoga, OH Franklin, OH Orange, FL Pima, AZ Westchester, NY Erie, NY Hillsborough, FL Salt Lake City, UT Hennepin, MN El Paso, TX Montgomery, MD St. Louis, MO Dallas, TX Bexar, TX Fulton, GA Pinellas, FL Shelby, TN Pierce, WA Baltimore, MD Sources: Authors’ calculations based on various FY 2014 plan and government financial reports and actuarial valuations; and U.S. Census Bureau (2014). 19
…and cities. 10% 20% 30% 40% 50% 60% 70% 0% Chicago, IL Detroit, MI San Jose, CA Census Bureau (2014). Sources: Authors’ calculations based on various FY 2014 plan and government financial reports and actuarial valuations; and U.S. Miami, FL Houston, TX Baltimore, MD Cities: Required Payments for Pensions, OPEB, and Interest Payments Wichita, KS Portland, OR Omaha, NE Boston, MA Mesa, AZ Milwaukee, WI as a Percentage of Own-Source Revenue, 2014 Dallas, TX Tucson, AZ Phoenix, AZ New York, NY Oakland, CA Louisville-Jefferson, KY Las Vegas, NV Fort Worth, TX Sacramento, CA Minneapolis, MN Atlanta, GA Albuquerque, NM San Francisco, CA Los Angeles, CA Honolulu, HI Columbus, OH Philadelphia, PA Cleveland, OH Nashville-Davidson, TN El Paso, TX Fresno, CA Austin, TX Virginia Beach, VA Charlotte, NC San Diego, CA Required pension payments Required OPEB payments Debt service Jacksonville, FL Denver, CO Indianapolis, IN Kansas City, MO Memphis, TN Long Beach, CA Tulsa, OK Raleigh, NC Seattle, WA Oklahoma, OK Washington DC San Antonio, TX Colorado Springs, CO 20
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